What is Bitcoin?

Bitcoin is a “cryptographic currency” that was first proposed in 2008 by a programmer using the supposed alias Satoshi Nakamoto.

In early 2009, Nakamoto released software that would implement the creation, sending and receiving Bitcoins over a peer-to-peer network.

His main motivation was to avoid the need for “financial institutions serving as trusted third parties to process electronic payments” such as a bank or PayPal.

The scheme allowed the receiver to be sure the Bitcoin received was genuine and hadn’t been sent elsewhere.

Nakamoto also thought Bitcoins would be largely anonymous.

Although theoretically possible, the exact nature of this anonymity is still being debated and it’s clear that, to achieve it, users need to take a series of precautions.

Other side of the coin

It was the anonymity of Bitcoin and its relation to an illicit online market place called Silk Road that really brought Bitcoins to the public’s and US Government’s attention.

Silk Road can be used, among other things, to buy and sell drugs and other contraband.

This led two US Senators to demand Silk Road be [shut down](http://en.wikipedia.org/wiki/Silk_Road_(bitcoin) and Bitcoin investigated.

Further concern was expressed that Bitcoins could be used for money-laundering (although, given the relatively illiquid nature of the currency, this would be on a relatively small scale).

The fact Bitcoin was adopted by organisations such as Wikileaks and LulzSec would not have surprised anyone.

While the US authorities could bring pressure to bear on financial institutions such as Visa, Mastercard or PayPal to stop payments going to Wikileaks, there is no central authority in charge of Bitcoin, making it very much more difficult to control.

Having said that, it’s not clear how much funding Wikileaks receives in the form of Bitcoins.

Using Bitcoins

You can get Bitcoins in two ways. The first, and most difficult, is through what is called Bitcoin mining.

This involves using computers to perform some of the cryptographic operations involved in making the Bitcoin network work. If you are the first to solve the calculations, you are rewarded with a certain number of Bitcoins.

A simpler way of getting Bitcoins is to buy them through one of the many Bitcoin exchanges.

One such exchange is Mt Gox, which allows you to buy Bitcoins using funds transfers of ordinary cash and e-Cash.

Once you’ve added funds to your account, buying Bitcoins is like buying shares: you can place an order to buy at the market rate or at a preferred rate.

Once you have the Bitcoins, you can leave them in your account on the exchange. You can also transfer them to a digital wallet on your computer or to an online e-wallet service.

You can then use your Bitcoins to buy goods and services ranging from books to website development to legal services.

It seems clear the majority of Bitcoin is being bought and sold for investment purposes. This is another underlying cause for some of the fluctuation in rates that have beset the currency, which has seen its value go from US$1 to US $30 USD at its peak. It is currently around US $10.

Safety concerns

The underlying system of transferring Bitcoin may be secure enough, but Bitcoin suffers from a number of vulnerabilities that have led to widely-publicised problems in the Bitcoin universe.

One of the first Bitcoin incidents occurred in June 2011 when Mt Gox was hacked and the user database of 61,000 users was taken.

The hackers used those usernames and passwords to transfer 25,000 Bitcoins – approximately US$225,000 – to an account.

From there, they then tried to sell them on, but succeeded in only removing about $1,000-worth because of the daily limit imposed by Mt Gox.

As a consequence of the hack, the exchange rate for Bitcoin on Mt Gox plummeted before climbing back to the pre-hack level.

The second event was when another Bitcoin service, MyBitcoin.com, was hacked resulting in the site closing down along with all of the account holders’ Bitcoins.

Approximately US$2 million of Bitcoin (valuation at the time) was lost, with one account holder who helped promote the site to family and friends losing about $250,000.

And then there was Bitomat, another Bitcoin site.

Based in Poland, a technical error on the part of the operator caused the server to crash, losing access to the Bitcoins in the process.

Mt Gox has recently taken over the accounts of Bitomat and offered to refund the lost coins to those users to help ensure the continuation of Bitcoin.

Future of Bitcoin

The “idea” of Bitcoin clearly has resonance with certain groups of people.

An electronic currency free from mediation and interference of governments and corporations, and which can be anonymous, is ideal for groups operating on the fringes of society – activists (cyber or otherwise), libertarians and, yes, criminals.

Whether the implementation of Bitcoin as it currently stands survives or it’s ultimately replaced by a variant will depend on how many other things go wrong, and also on the development of more robust and easy to use software.

Certainly, the recent Bitcoin events are growing pains in comparison to the fall out of the Global Financial Crisis and what countries, companies and individuals have lost as a result of a largely self-regulated financial industry.

Ironically, Bitcoin may end up being more resistant to national and corporate manipulation and possibly more robust as a result.

Still, if you’re going to use Bitcoins, do so carefully and with small amounts of money that you can afford to lose.